The Collected Works of James M. Buchanan volume 2 Public Principles of Public Debt James M. Buchanan The Collected Works of James M. Buchanan volume 2 Public Principles of Public Debt A Defense and Restatement liberty fund Indianapolis This book is published by Liberty Fund, Inc., a foundation established to encourage study of the ideal of a society of free and responsible individuals. The cuneiform inscription that serves as our logo and as the design motif for our endpapers is the earliest-known written appearance of the word ``freedom'' (amagi), or ``liberty.'' It is taken from a clay document written about 2300 b.c. in the Sumerian city-state of Lagash. q 1999 by Liberty Fund, Inc. All rights reserved Printed in the United States of America First published in 1958 by Richard D. Irwin, Inc. 03 02 01 00 99 c 54321 03 02 01 00 99 p 54321 Library of Congress Cataloging-in-Publication Data Buchanan, James M. Public principles of public debt. p. cm. Ð (The collected works of James M. Buchanan ; v. 2) Includes bibliographical references and index. isbn 0-86597-215-x (alk. paper). Ð isbn 0-86597-216-8 (pbk. : alk. paper) 1. Debts, Public. I. Title. II. Series: Buchanan, James M. Works. 1999 ; v. 2. hj8015.b8 1999 336.384Ðdc21 98-45533 liberty fund, inc. 8335 Allison Pointe Trail, Suite 300 Indianapolis, IN 46250-1684 ``I ®nd little use for the hypothesis that error becomes truth merely by long or consistent practice.'' ÐHenry Simons, ``On Debt Policy'' ``I must confess, that there is a strange supineness, from long custom, creeped into all ranks of men, with regard to public debts, not unlike what divines so vehemently complain of with regard to their religious doctrines.'' ÐDavid Hume, ``Of Public Credit'' Contents Foreword xi Preface xvii 1. The Economists and Vulgar Opinion 3 2. The New Orthodoxy 5 3. The Methodology of Debt Theory 18 4. Concerning Future Generations 26 5. The Analogy: True or False? 38 6. Internal and External Public Loans 58 7. Consumption Spending, the Rate of Interest, Relative and Absolute Prices 67 8. A Review of Pre-Keynesian Debt Theory 79 9. Public Debt and Depression 95 10. War Borrowing 104 11. Public Debt and In¯ation 111 12. When Should Government Borrow? 115 13. Should Public Debt Be Retired? 134 14. Debt Retirement and Economic Stabilization 143 ix x Contents Appendix. A Suggested Conceptual Revaluation of the National Debt 149 Index of Authors 165 Index of Subjects 166 Foreword Begin with a picture. Here is the young Jim Buchanan, strolling down the stairs of the Hotel d'Inghilterra in Rome after breakfast in early 1957. He is preoccupied. His brow is slightly furrowed. Suddenly, he looks up, and his head tilts back. A slightly incredulous look comes over his face. Apparently, something puzzling had in an instant become clear. He races down the re- maining steps and hurries over to a small writing room that graces the foyer of the hotel. Grabbing some pieces of hotel stationery, he proceeds feverishly to jot down the crucial points. Public Principles of Public Debt 1 is born. It is, for Buchanan, the only book that will come about in this wayÐas a ¯ash of inspiration. Other works may be no less inspired in an intellectual senseÐand no less inspiring to readers. But Public Principles of Public Debt is the only work that will begin with an experience of quite this Road-to- Damascus quality. And the feverishness does not end here. The central point of the argument, once seen, is so obvious to BuchananÐthe prevailing or- thodoxy on public debt incidence (which he had previously thoroughly im- bibed) so clearly wrongÐthat he cannot wait to get the book written and into print. As he presses forward with the writing, he anxiously examines the journals, fearful that with so obvious a point he might well be scooped. The natural impulse of intellectual excitement works together here with consid- erations of professional prudence to drive him on. Was he right to be anxious? To judge by the book's puzzled reception and the confused literature about it that emerged over the ensuing decade, prob- ably not. What was obvious to Buchanan was clearly not so obvious to ev- eryone else. Indeed, there remained a constituency, particularly within mac- 1. James M. Buchanan, Public Principles of Public Debt: A Defense and Restatement (Homewood, Ill.: Richard D. Irwin, 1958), volume 2 in the series. xi xii Foreword roeconomics, that was staunchly resistant to and suspicious of the Buchanan insights. Nonetheless, Buchanan was right to feel that much was at stake, both professionally and academically; Public Principles of Public Debt was, af- ter all, Buchanan's ®rst monograph. And in this sense, it added a depth and substance to his vita to set alongside the impressive array of important jour- nal articles he had already produced. Moreover, the line of argument had im- portant in¯uences on his subsequent work. For example, the subjective cost theme in Cost and Choice 2 owes much to the re¯ections about cost that are developed in Public Principles of Public Debt, and the important public choice implications of the Public Principles of Public Debt argument surface explic- itly in Democracy in De®cit.3 To elaborate, part of the concern of the ``new orthodoxy'' in claiming that the burden of debt (at least, internal debt) is borne currently, in the period that the expenditure is undertaken and precisely not passed forward to future generations as (allegedly mistaken) popular view might have it, was to offset ethical inhibitions about de®cit ®nancing. If Buchanan's claim was right, and the burden of debt ®nancing was indeed borne by ``future generations,'' then debt ®nancing might well encourage both excessive reliance on debt and ex- cessive levels of spending. To the extent that the future generations in ques- tion were indeed different persons, not alive (or not enfranchised) at the time the expenditure operation was undertaken, then the ®scal operation would not (and by de®nition could not) ful®ll the Wicksellian contractarian requirement that virtually all affected parties should be free to reject the ex- penditure. In the absence of a restriction on debt ®nancing, ordinary demo- cratic processes could not prevent the current generation of voters-taxpayers from passing forward the cost of as much current expenditure as they were inclined to andÐif the cost was to be borne by othersÐvoting for them- selves projects whose total bene®ts, though positive, did not exceed total costs. These aspects remain entirely in the background in Public Principles of Public Debt. The object in this ®rst book by Buchanan is to establish a set of analytic claims about debt incidence. But the public choice aspects do pro- 2. James M. Buchanan, Cost and Choice: An Inquiry in Economic Theory (Chicago: Markham Publishing Co., 1969), volume 6 in the series. 3. James M. Buchanan and Richard E. Wagner, Democracy in De®cit: The Political Leg- acy of Lord Keynes (New York: Academic Press, 1977), volume 8 in the series. Foreword xiii vide some of the (possibly unconscious) subtext in Public Principles of Public Debt that Buchanan and Wagner, in Democracy in De®cit and elsewhere, make explicit and develop in a more complete way. These public choice anxieties are, of course, very much in play in the more recent debate over implicit social security debt. This latter debate has, in fact, proceeded somewhat independently of the Buchanan book and has focused on slightly different aspects of the whole issue. In particular, it has been mainly concerned with the question of the effects of debt ®nancing on the capital stock. The classic papers here revolve around the rival claims of Martin S. Feldstein and Robert J. BarroÐthe former claiming to establish econometrically the empirical magnitude of the effects of social security ar- rangements on the United States capital stock, the latter purporting to show (through a reinvention of the so-called Ricardian equivalence theorem) that, for fully rational individuals, public debt will have virtually the same effect as taxation.4 It is an interesting twist here that Barro's agenda is in part an anti- Keynesian one. In 1958, the Keynesian position was that (internal) debt and tax ®nancing were more or less equivalentÐat least in the intertemporal al- location of burdens. By 1974, however, the Keynesian position seemed en- tirely reversed. It was, by 1974, recognized that if taxes and debt were essen- tially equivalent, then standard macroeconomic policy measures based on de®cit management could have no effect on the economyÐmacroeconomic or otherwise. In fact, the Barro-Feldstein debateÐor the debate that might have beenÐgot somewhat sidetracked because of problems with the repli- cability of Feldstein's data. However, it should be clear that neither Barro's conclusions nor his approach would be particularly congenial to Buchanan. It is essential to Buchanan's argument that debt ®nancing has an effect: the difference between Buchanan and the Keynesians was rather whether such effects were desirable or not. More to the point, perhaps, Barro's central question (and the title of his in¯uential paper)Ð``are government bonds net wealth?''Ðis set at a more aggregative level than Buchanan's analysis in Pub- lic Principles of Public Debt. Indeed, in an important sense, the basic contri- 4. Martin S. Feldstein, ``Social Security, Induced Retirement, and Aggregate Capital Accumulation,'' Journal of Political Economy 5 (September±October 1974): 905±26; Rob- ert J. Barro, ``Are Government Bonds Net Wealth?'' Journal of Political Economy 6 (No- vember±December 1974): 1095±117.